Risk off: What does it mean and how does it affect your trades?

1 June

Risk off: What does it mean and how does it affect your trades?

Risk off and risk on are terms regularly used by traders and investors to refer to market sentiment.  In our latest blog, Senior Trader Mentor, Angeline Feliciano, takes a look in more detail at the term and how it relates to what we saw in the market last week.

In the middle of last week (May 21 – May 25), we saw massive drops across some major currency pairs. Both AUD/USD and NZD/USD dropped by over 80 pips from their high seen on Tuesday, which then carried on to Wednesday’s trading. EUR/CHF also dropped by 200 pips in less than 24 hours, to fall below the 1.1600 handle on Wednesday and USD/JPY saw its biggest two-day drop since March 25 2018 – 244 pips, down to 108.94.

With no high impact economic reports or political events scheduled on the calendar, we would have expected Wednesday to have been a quiet day in the markets. Those who had done their research and tried to make sense of the moves in the markets that day, would likely have come across the term ‘risk off.’

What does ‘risk off’ mean and how does it affect your trades?

Market sentiment

Just like you, the market has feelings. This is generally referred to by analysts as market sentiment. Simply put, market sentiment describes the overall attitude or feeling of the market towards risk.

Risk appetite

Within market sentiment you can see whether there is a risk appetite within it, otherwise known as ‘risk on.’ This is when participants seek higher returns on their investments. Risk appetite is often triggered by good news such as better political relationship between North and South Korea, positive economic data or higher earnings reports from big companies.

 Risk aversion

On the flip side, risk aversion or ‘risk off’ is when market participants worry about the safety of their investments. This could be triggered by events that elicit panic among investors, two examples of this which happening last week is the President of America, Donald Trump implying there could be a trade war with China, and secondly, Italy found itself caught in a political deadlock, not knowing who their next Prime Minister would be.

Why is it important?

Since market sentiment describes the market’s overall feeling or tone, knowing about it can help you pick out which currencies you may want to trade.

Risk appetite is often characterized by a stronger performance of the equities markets. Because of this you may want to go long on equities indices, such as NAS100, S&P500, and UK100. Some currencies are also considered as ‘risk’ currencies, namely: AUD, NZD, CAD, and GBP. This is because they typically have higher interest rates within their countries.

On the other hand, if you can see risk aversion in the market you can look to take trade in favor of the JPY, CHF, and USD, as they are considered as safe haven assets. We will look at the reasons why this is the case  in a future blog.

Below is a handy cheat sheet to ensure you do not get blindsided by the market’s mood swings.

Senior Trader Mentor, at Learn to Trade, Angeline Feliciano

For more information on risk on, risk off and reading market sentiment you can attend one of our free forex workshops.